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In a changing world, sustainability reaps rewards

A new generation of sustainability-linked loans is reshaping the market, putting more companies' green goals within reach.

Green
lending is transforming today's financial landscape, providing funding to a
wide range of corporates and incentivising business to build a more sustainable
future and it is continuing to gain traction.

It is widely recognised by organisations such as the
UN that the private sector must step up to help reduce the "emissions
gap". The corporate sustainable lending
sector is set to play a critical role in financing the transformation to a low
carbon economy. Although still only a
fraction of the estimated USD 66,550 billion lent to non-financial sector
corporates globally in 2017, there is growing appetite for sustainable lending
in the corporate and finance
communities. Despite challenges regarding regulation and standards, developing
this sector will free up finance to a host of firms.

Companies
currently have two main green financing options. The first is the "green bond",
used to

"The corporate sustainable lending sector is set to play a critical role in financing the transformation to a low carbon economy"

finance green projects. There were USD 895 billion green bonds in circulation 1 by the end of 2017, meaning issuance would have to
rise sixfold to fuel the global upgrade pipeline, according to data from the
Climate Bond Initiative.

Not all
companies can or want to issue debt securities, or have specific projects to
finance. This is where the second option, green lending, may help. Through
"sustainability-linked loans" or "positive impact loans", borrowers can access
general liquidity lending with terms linked to corporate progress on
sustainability.

The green
lending market is small but growing fast. Cecile Moitry, Director of
Sustainable Finance and Investment at BNP Paribas Corporate and Institutional
Banking (CIB), says last year's total volume of EUR4.5 billion of syndicated loans
was surpassed by the middle of February this year.

Holistic Sustainability Assessment

Many early
green loan structures proved too rigid.

"The tipping point was to switch from linking loans to individual projects to evaluating the company itself. That opened the market to a broader universe of corporates which already have a sustainability strategy in place"

Today's
green loans are more holistic. Companies are typically offered "standard"
pricing, built around normal risk and credit parameters. Specific key
performance indicators (KPIs) are then added to the loan contract. Companies
receive a discount as targets are reached. If targets are missed, they pay a
premium.

Performance is
reviewed by a third party organisation and such loans are open to companies of
sufficient size and financing requirements, providing they have suitable corporate
social responsibility policies in place.

"The target
to trigger the discount is quite significant; it is not a small thing. It
requires an effort," says Moitry.

In October
last year, Belgium's mail service Bpost agreed the country's first sustainability-linked
loan, signing a EUR300 million borrowing facility deal with a syndicate of four
banks including BNP Paribas, which ties loan terms to the company's overall
sustainability achievements.

Then in
December, BNP Paribas was part of another syndicate that agreed a EUR600
million revolving credit facility with Finnish renewable paper and packaging
manufacturer Stora Enso.
The company
was the first in its sector to integrate greenhouse gas emission targets for
its operations, suppliers and downstream transport providers. It aims to cut
its own emissions by 31% by 2030.

The terms of
the deal are directly linked to the company's success in cutting its own
emissions and other sustainability goals, such as encouraging suppliers to set
ESG targets. Stora Enso has committed to having 70% of its non-fibre and
downstream transportation suppliers set their own GHG reduction targets by
2025.

Differentiation on Sustainability

Stora Enso
Senior Vice President and Head of Group Treasury Martin Ros hopes the deal will
set a precedent.

"We
want to work with partners, including our banks, who are sustainable too,"
he says.

"It is
about differentiation on sustainability. We want other, non-financial metrics
to be part of the pricing. It is also a two-way street. If your company does
not adjust to a low carbon economy, financing should be more expensive,"
he says.

Ros wants to
take the concept further, building in other targets, such as worker welfare,
across more financing products. One day, sustainability should be an integral
part of all credit risk assessments, he thinks.

In February
this year, BNP Paribas also acted as a sustainability coordinator for the
refinancing of a EUR2
billion revolving syndicated credit facility with food and drinks supplier
Danone. The credit facility directly ties Danone's ESG performance to the loan pricing so
that the company will receive a discount when outperforming or a premium when
underperforming on its sustainability goals.

The switch
in focus to linking terms to a borrower's overall sustainability efforts is
welcomed by debt and capital specialist Jon Williams, Partner at PwC's
Sustainability and Climate Change division.

"I would
really like to see credit and green ratings integrated so I can see all the
factors, with the green risk alongside the operational and management risks,"
says Williams.

Regulators
are playing their part in encouraging greater transparency and evaluation of
corporate sustainability. Brazilian listed companies have had to "disclose or
explain" for many years. France is now following suit, with new disclosure
requirements on energy transition.

Carrot and stick regulation

A recent
report by Dutch regulator De Nederlandsche Bank warns of bubbles if regulation
and oversight are not constructed correctly. Maarten Vleeschhouwer and Henk Jan
Reinders, two of its authors, are looking at how green criteria can be
incorporated into oversight frameworks.

"We need to
disentangle the risk components. If it can be shown that 'brown' [i.e. carbon
intensive] is higher risk, then it should be penalised. But should prudential
policy be used to encourage green by cutting capital requirements? No, we think
supervisory frameworks should remain fully risk-based," says Henk Jan Reinders.

Maarten
Vleeschhouwer also points out that green supporting factors would lower the
aggregate capital in Europe's banking system. Brown penalising factors would do
the opposite, making the banking system more resilient.

There are
other non-regulatory ways to encourage green lending, says Careen Abb, leader
of the UN's Positive Impact Finance initiative. A white paper is due in April
to explain how governments, public bodies, borrowers, investors and bankers can
work more closely on business models and financing structures.

Abb gives
the example of a town wanting to switch to LED street lighting. The project
could deliver lower emissions but comes with big up-front costs. If the
financiers, council and contractors work together before a deal is signed, they
could install electric-vehicle charging points to the lampposts too, ensuring
the project generates revenues to mitigate part of the cost.

"Banks
can differentiate themselves by their ability to engage and advise their
clients on developing impact-based business – in which positive impacts are not
an externality but central to the business model itself," says Abb.

Regulation –
by carrot or stick – can also help spread a more sustainable financing culture,
she thinks. But it cannot solve the financing gap alone. She suggests lenders
take a longer, strategic view, always keeping the "impact" considerations front
of mind as they develop new green lending lines.